Covid-19: Commercial and Legal Considerations for Private Fund Managers
The novel coronavirus (“COVID-19”) pandemic has caused significant disruption to the global economy, and the asset management industry is no exception. This is above all a human and social crisis, necessitating some significant changes in the way everyone goes about their daily lives. As efforts are underway to manage the spread, the impact to businesses and economies, while still indeterminable in the long term, has become increasingly significant.
We are finding from our clients that many business continuity plans are not robust enough to help businesses manage the growing and evolving global nature of the pandemic and its potential disruption, both in the short and long term.
This note highlights some important considerations and provides practical guidance to assist asset managers and their legal teams in tackling the challenges presented by COVID-19.
This note supplements the wide array of Linklaters’ COVID-19 related resources which can be accessed here. If you have questions relating to your matters or how to mitigate the impact of COVID-19 on your business, either in the Americas or globally, please let us know.
Key Issues for Asset Managers to Consider
Investor communication: It is important from an investor-relations perspective to maintain regular contact with all investors throughout the pandemic to reassure investors about a firm’s contingency plans for remote working and for continuing “business as usual”.
Business continuity plans: Sponsors should monitor their business continuity plans and consider whether any updates are required to cater for COVID-19. Sponsors should also review the continuity plans being implemented by their portfolio companies, key service providers and other counterparties during the pandemic to ensure continuity of crucial business services.
Data protection: Sponsors should ensure that vital data protection, backup and recovery processes are functioning properly to secure the sponsor’s books and records. Given the number of employees working remotely, particular attention should be paid to cybersecurity and ensuring employees’ use of technology is properly monitored and recorded.
Marketing: Sponsors actively fundraising face increasing challenges as a result of travel restrictions, market volatility and a global shift away from face-to-face meetings. Investors may also be experiencing operational challenges that delay document review, negotiation and execution. Accordingly, sponsors may consider seeking to extend the duration of their fundraising periods to accommodate any delays associated with the pandemic.
Disclosure: Sponsors actively engaged in marketing activities should review their disclosure materials and ensure that they include additional disclosures and risk factors addressing COVID-19 and its potential impact on such sponsors’ business activities. Sponsors should consider including enhanced disclosure regarding past performance figures, especially with respect to industries and regions that are most adversely affected by the pandemic.
Diligence requests: Sponsors should be prepared to provide updated responses to continued investor due diligence, particularly as relates to past performance during previous market dislocations and implementation of the firm’s business continuity plans during the pandemic. See below under “Looking Forward; Investor Perspective”.
Liquidity and default: Sponsors should be prepared to address investor liquidity issues in the coming weeks/months as investors navigate the public market downturn and general slowdown in private equity deal activity. In doing so, sponsors should review the transfer and default provisions in their fund governing documents and have contingency plans in place if investors are unable to meet capital call obligations.
Credit facilities: Sponsors may need to rely on their credit facilities to provide day-to-day working capital and liquidity to their portfolio companies. Accordingly, sponsors should review their fund governing documents and credit agreements to determine whether limits on their existing credit facilities provide sufficient short-term flexibility. If necessary, sponsors may want to seek investor approvals to permit additional indebtedness and/or to extend time limits on outstanding borrowings. In addition, some sponsors may consider promptly calling capital from investors to pay down outstanding balances on fund subscription facilities so that they are better-positioned in the event investor liquidity challenges arise in the near future.
SEC Extensions for Form ADV and Form PF Filing Deadlines
On March 13, 2020, the SEC issued an order (the “Order”) providing investment advisers temporary relief from certain Form ADV and Form PF filing and reporting obligations by extending any filing deadline falling before April 30, 2020 by up to 45 days.
Who Benefits From the Relief?
Designed to enable funds and advisers to meet their filing deadlines amidst the operational disruptions caused by COVID-19, the Order applies to:
registered investment advisers (i) filing an amendment to Form ADV; (ii) delivering amended brochures, brochure supplements or summaries of material changes to clients (Form ADV Part 2); and (iii) filing Form PF; and
exempt reporting advisers filing reports on Form ADV Part 1A.
Process for Obtaining Relief
The Order is not a blanket extension for all investment advisers; it is only intended to apply to investment advisers that are adversely affected by COVID-19. Any adviser relying on the Order must promptly notify the SEC via email and, in case of a registered investment adviser, must disclose on its public website (or if it does not have a public website, promptly notify its clients and/or private fund investors) that it is relying on the Order.
The notice must include:
a brief description of the circumstances related to the current or potential effects of COVID-19 preventing the adviser from filing or delivering the applicable form on a timely basis; and
the estimated date by which the adviser expects to file or deliver such form, which date may be no later than 45 days from its original due date.
Advisers to Evaluate Carefully Whether to Take Advantage of the Relief
The SEC encouraged advisers seeking to rely on the Order to continue to evaluate their fiduciary duties, reminding them of the existing high standards of reporting and risk management applicable to investment advisers in the alternative investment fund industry. As a result, we expect advisers will hesitate to take advantage of the filing extensions unless absolutely necessary, given the public disclosure requirements and the increasing focus of investors and regulators on the business continuity plans of such advisers.
FINRA Notice on Business Continuity Plans
The U.S. self-regulator of securities broker-dealers, the Financial Industry Regulatory Authority (“FINRA”), recently issued guidance (i) encouraging its member firms to review their business continuity plans (“BCPs”), and (ii) providing limited regulatory relief in light of the global outbreak of COVID-19.
Member firms, which include U.S. distributors of funds, should ensure that their BCPs address pandemic preparedness, including whether those BCPs are sufficiently flexible to address operational disruptions and other effects arising from the pandemic (e.g., staff absenteeism, use of remote offices or telework arrangements, travel or transportation limitations and technology interruptions or slowdowns).
In addition, FINRA notes:
BCPs should address communication with customers during periods of significant business disruption, including to ensure customer access to funds and securities;
firms are encouraged to place notices on their websites with contact information related to executing trades, client accounts and access to funds or securities;
firms should review their emergency contacts required under FINRA Rule 4370 to ensure that FINRA has a reliable means of contacting each member; and
firms are encouraged to contact their assigned FINRA Risk Monitoring Analyst to discuss the activation and implementation of their BCPs, as well as to discuss any issues they may be facing, including the disruption of business operations, and whether disruptions are solved or ongoing.
The notice also details certain regulatory relief for member firms affected by COVID-19:
FINRA is temporarily suspending the requirement to maintain updated Form U4 information regarding office of employment addresses for registered persons who temporarily relocate;
firms are not required to submit branch office applications on Form BR for any newly opened temporary office locations or space-sharing arrangements established as a result of recent events;
if a firm relocates personnel to a temporary location that is not currently registered as a branch office or identified as a regular non-branch location, the firm should use its best efforts to provide written notification to its FINRA Risk Monitoring Analyst as soon as possible; and
member firms that require extra time to respond to open inquiries, investigations or upcoming filings may seek extensions by contacting their Risk Monitoring Analysts or the relevant FINRA department. FINRA may also waive any late fees incurred by a member firm based on the member firm’s particular circumstance.
Impact on Contracts with Service Providers and Third Parties
In our experience, any event that leads to public disruption can be a fertile breeding ground for formal disputes to arise in the context of commercial contracts, whether through missed obligations, disruption to services and supply chains or defaults arising from financial distress.
When this happens, in-house legal teams will often be asked to provide detailed advice on key legal themes that funds, their sponsors or advisers might face, including the concepts described below (a more detailed note covering these issues is available here).
Many contracts will contain force majeure clauses that will excuse one or both parties from performance of the contract in some way following the occurrence of certain events. The relevant events are often defined as acts, events or circumstances beyond the reasonable control of the party concerned. In order to be upheld by the courts, any such clause will need to be clearly defined and sufficiently clear.
Force majeure clauses may specifically identify epidemics or pandemics, while others may reference “acts of government” which could apply in the event of government-imposed quarantines or other restrictions. It is crucial that advisers understand how any force majeure clauses in their contracts work and what their duties and options are under such clauses (e.g., requirements to have implemented a business continuity plan, to provide notice and/or to mitigate losses).
Impracticability and Frustration
The doctrine of impracticability discharges a party’s performance when an event (the non-occurrence of which was a basic assumption on which the contract was made) makes the performance of the contract impracticable. Generally, price changes or other events must be such that the performance would create extreme and unreasonable difficulty, expense, injury, or loss; noting that price increases of as much as 58% have been held to be insufficient by U.S. federal and state courts.
The doctrine of frustration excuses a party’s performance under a contract when an unforeseeable event destroys the underlying reasons for performing the contract, meaning that the performance of the contract would be worthless to the other party.
Material Adverse Change
Contracts should also be checked to see whether they contain material adverse effect or material adverse change clauses. These clauses typically permit a party to avoid performance or terminate an agreement because of a significant change in circumstances affecting the transaction value. Such clauses are typically construed narrowly, and whether COVID-19 will trigger the provision will depend heavily on the specific wording of the clause and the particular circumstances involved.
The list of exclusions included in any applicable insurance contracts should be considered carefully to analyze whether any losses suffered as a result of COVID-19 may be covered by the relevant policy.
Whether an adviser is currently fundraising or is focusing on making investments for an existing fund, we expect that the following issues will be front of mind over the coming months:
Investment opportunities: Sponsors may seek to capitalize on the market dislocation by investigating new investment opportunities, such as distressed assets or public equity securities. Sponsors should undertake a careful review of their fund documents to determine whether such investments are permitted and what, if any, steps are necessary to achieve the required flexibility. Similarly, disclosure documents should be revisited to ensure such investments are not out of scope, and consideration should be given as to whether additional disclosure is necessary.
Fund terms: Funds nearing the end of their term may seek term extensions to provide portfolio investments with ample time to recover from short-term depreciation in value. Similarly, we expect sponsors to build additional flexibility into their fund documents for new fundraises to enable investment periods and fund terms to be extended in order to deal with market dislocations.
Fundraising periods: Sponsors may seek to introduce more flexible fundraising periods for new funds (e.g., permitting an automatic 6-month extension to accommodate investors who commenced negotiations before the end of the original fundraising period).
Follow-on investments: In the short term, we anticipate that sponsors will utilize follow-on investments to provide additional capital to portfolio companies that are experiencing shortfalls. As such, sponsors should review the follow-on provisions of their fund documents to ensure they have adequate flexibility to provide such capital.
Conversely, in light of market volatility, investors are likely to push for increased disclosure from sponsors and may seek to negotiate changes to certain fund terms. Issues may include:
Business continuity and diligence: We expect investors to seek additional comfort that sponsors and their portfolio companies are well-equipped to function during an extended “work-from-home” environment. Sponsors should be prepared to describe or share their business continuity plans and to respond to questions regarding sponsors’ deal pipelines, investment allocations and investment strategies (including, to the extent applicable, performance during prior market dislocations).
Logistical support: As teams are adapting to working remotely, we expect to see short-term needs for increased logistical support and flexibility, including with respect to the funding of capital calls and the execution of documents (including the acceptance of digital signatures). Similarly, advisory committee meetings and limited partner meetings may need to transition to voice- or video-conferencing, or web-streaming.
Capital commitment thresholds and other key terms: Adopting the lessons learned from the global financial crisis, we expect investors to push for additional comfort with respect to new fundraises. This may include first-close investors making their subscriptions contingent on the fund closing on a minimum percentage of target commitments (e.g., 50%) to ensure the fund is viable and an increased scrutiny on borrowing limits, credit facility provisions, duration of fundraising periods and descriptions of investment strategies.